The Breakdown - Are El Salvador’s Bitcoin ‘Volcano Bonds’ an End Run Around the IMF?

Episode Date: November 23, 2021

This episode is sponsored by NYDIG. Today on “The Breakdown,” a check in on El Salvador, where President Nayib Bukele has just announced “Bitcoin City,” a new community that will feature no income or capital gains tax and be designed to attract talent from around the world. The effort is being funded in part by a $1 billion bond that some are calling the “Volcano Bond.” The bond will be tokenized by Blockstream on Liquid and available for trade on Bitfinex. NLW covers the bitcoin world’s reaction to the news (as well as some fintwit skepticism).  NYDIG, the institutional-grade platform for bitcoin, is making it possible for thousands of banks who have trusted relationships with hundreds of millions of customers, to offer Bitcoin. Learn more at NYDIG.com/NLW. Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Join the discussion: https://discord.gg/VrKRrfKCz8   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW “The Breakdown” is written, produced by and features Nathaniel Whittemore aka NLW, with editing by Rob Mitchell, research by Scott Hill and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Dark Crazed Cap” by Isaac Joel. Image credit: Jaime Mejia/iStock/Getty Images Plus, modified by CoinDesk.

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by Nidig and produced and distributed by CoinDesk. What's going on, guys? It is Monday, November 22nd, and today we are talking about El Salvador, Bitcoin bonds, volcano bonds, and geo-strategic intrigue. But first, I just wanted to give you guys an expectation. around the holiday schedule. So obviously in the U.S., the Thanksgiving holiday is coming up, and I'll be doing a series of short interviews for the days surrounding the holiday.

Those will kick in, I think, on Wednesday and run through the weekend before coming back to our normal schedule next week. I love using these holidays as ways to catch up on people's takes and opinions on things that have happened over the last, however long it's been since I've had a chance to talk with them. So I hope you enjoy that. I am pretty sure that you will. I've got some great guests coming.

But today, as I mentioned, we are talking El Salvador. And I want to start with the headline that is blasted all over the internet today. On CoinDesk, El Salvador to create Bitcoin City. Use 500 million of planned $1 billion bond offering to buy more crypto. From Bloomberg, El Salvador plans tokenized Bitcoin bonds and tax-free Bitcoin City. From the block, El Salvador government strikes deal with Bitfinex and Blockstream to issue $1 billion Bitcoin bond. Sounds pretty big, right?

Well, it's interesting on multiple geopolitical levels, but first, let's do a little bit of background and catch up on what's been happening in El Salvador this year. In case you somehow missed it, at the end of May, President Naipu Kelly of El Salvador announces that he would be proposing a law to make Bitcoin legal tender. He did this at the Bitcoin Conference in Miami after being introduced virtually by Jack Mahlers of strike. A few days later, in June, the legislature, voted it through. El Salvador was set to become the world's first Bitcoin nation. These were heady times, man. On the night that the legislation was being voted upon,

there was a Twitter spaces that was basically being held live from the parliament floor. President Naibu Kelle was in the spaces for a while, as was his brother and campaign manager. There was a ton of discussion not just about what the legislation meant or anything like that, but about future ideas. It was, in fact, in that Twitter, Twitter spaces that the idea of Bitcoin mining via volcano energy, i.e. geothermal energy, came up. That's something we're going to get into in just a minute. But for as exciting as it was to those of us in the Bitcoin community, it wasn't necessarily exciting everywhere else. Also in June, and I think this will be important to our story, the World Bank denied El Salvador's request for help

on technical implementation of their new Bitcoin standard. A World Bank spokesperson said, we're committed to helping El Salvador in numerous ways, including for currency, transparency, and regulatory processes. While the government did approach us for assistance on Bitcoin, this is not something the World Bank can support, given the environmental and transparency shortcomings. Now, at the time, I said that I thought, especially that transparency shortcoming idea was ludicrous, but what matters to our story is that that was the World Bank's formal take. The IMF, on the other hand, threw kind of mixed signals. In some venues, there was reporting that they were having productive conversations. But on June 10th, Reuters published an article called,

quote, IMF sees legal and economic issues with El Salvador's Bitcoin move. Jerry Rice and IMF spokesperson said, adoption of Bitcoin as legal tender raises a number of macroeconomic, financial, and legal issues that require very careful analysis. We are following developments closely and will continue our consultations with the authorities. Now, a little over a month later on July 26, the IMF published a blog called Crypto Assets as National Currency Question Mark, a step too far. And to be fair, this article did not mention El Salvador by name, but it's pretty clear who they were focused on. The concluding paragraph of that piece read, as national currency crypto assets, including Bitcoin, come with substantial risks to macrofinancial

stability, financial integrity, consumer protection, and the environment. The advantages of their underlying technologies, including the potential for cheaper and more inclusive financial services, should not be overlooked. Governments, however, need to step up to provide these services and leverage new digital forms of money while preserving stability, efficiency, equality, and environmental sustainability. Attempting to make crypto assets a national currency is an inadvisable shortcut. Now, you might be asking yourself, why should we even care what the IMF thinks, but we'll come to that in a little bit. So, the summer sees this idea settling and technical development happening, and on September 7th, a very auspicious day, my birthday,

the Bitcoin legal tender law goes into effect. The government launches their crypto wallet Chivo, which is apparently slang for cool, and gifts anyone who downloaded the wallet $30 worth of Bitcoin. Now, the rollout has not been without controversy. First, there have been numerous technical challenges. One of the members of our Breakers' Discord was just down there with Biscoint.io and reported some of these challenges, like ATMs requiring long confirmation times,

and just service providers not necessarily being super enthusiastic about accepting it. Now, my honest read here is that wiring up an entire nation to take a new currency has fairly significant technical and social burdens. On the technical side, it's not that we should be excited about any of the challenges that El Salvador has faced, but nothing has seemed particularly egregious to me. Nothing has seemed out of the realm of what you might expect with such a radical shift. On the social side, when you've trusted a currency like the U.S. dollar for a long time, and then all of a sudden this thing's come out of nowhere and is mandated,

of course there's going to be some amount of resistance. Of course there's going to be a trust hurdle. And frankly, this is part of the challenge with the Bitcoin mandate. It inherently breeds some amount of mistrust. That doesn't make it not the right decision for the country. I'm not really commenting on that. It's just that even if it is the right decision, it's going to come with consequences.

And people feeling put upon because they're literally being put upon is one of them. Indeed, the mandate for people to accept Bitcoin is definitely one of the most contentious parts of this law, even among Bitcoiners. NIDIG sponsors this podcast and they're integrating Bitcoin into everyday life, not only for Wall Street, but also for Main Street, because NIDIG is built for Bitcoin and Bitcoin is built for everyone. Learn more at nidig.com slash NLW. That's nydig.com forward slash NLW.

Still, in many ways, the biggest issue since rollout haven't been about Bitcoin per se, but about what it represents about the president himself. There is concern among some, both internationally and in El Salvador, that Buckele is venturing down the path to autocracy. His very public display last year of bringing armed military into the parliament building to push a defense bill through. The removal of more than 100 judges, which they claimed were hopelessly corrupt from the era before, and who knows, perhaps they were. A stacked Supreme Court allowing Buckele to run again for president in 2024. These are big flashing warning signs for those who watch global politics, and particularly for those who have watched dissents into autocracy before. I don't believe that that

means Buccelli should be written off entirely. Indeed, Alex Gladstein of the Human Rights Foundation has often made the point that if he was tending towards autocrat, he's made a strange choice to go so deep on a currency that he cannot control. It is in many ways outside of the dictator's handbook. Still, to give a flavor for that alternate side to the excitement that's so often prevalent in the Bitcoin community, a Reddit user Snow 75, who claims to be from El Salvador, says, My country is walking towards a dictatorship. Government expenses are off the roof, and the president is gambling our money in Bitcoin. Poor third-world countries aren't ideal for economic experiments. A rich country with spare money could roll a trial, but here it's taking

funds that could be spent on education, infrastructure, or health. End quote. It seems to me that this explains a lot of the anti-Bitcoin protests that we've seen around the country. country. They are less about Bitcoin and more about Bitcoin as another representation of Buckele. Still, despite all of this, Buckele has reported encouraging statistics on adoption. Within 10 days, the country was touting more than 1 million users of the Chivo wallet, and that's in a country of 4 million people. Then on November 14th, Buckele tweeted, there is one country on earth where there are more people using Bitcoin wallets than bank accounts. The El Salvador government has also been stockpiling Bitcoin. On October 27th, President Buckele tweeted that they had bought the

dip and added 420 Bitcoin to their stockpile, at the time bringing their treasury to around 1,100 BTC. They also, going back to that idea from that Twitter Spaces night, had launched a pilot of the Volcano Power Project. Al Salvador has about 30 volcanoes of which 20 or so are potentially active. The first experiments with mining are in Berlin, which is about 112 kilometers south of San Salvador. The plant has 16, 2 to 3,000 meter deep shafts through which steam circulates to power three turbines. Now, most of that energy is still used for the country's grid, but some is now being hardest for Bitcoin mining as well. El Salvador has also announced some frankly kind of random uses of Bitcoin profits. At the beginning of October, they said they were going to use $4 million

in Bitcoin gains to fund a veterinary hospital, which is awesome, I guess, seems great if that's what people want, but it was very random and not necessarily what I think anyone expected. But this all brings us back to now. Last week was the LaBitConf, the Latin American Bitcoin and blockchain conference, and of course it took place in El Salvador this year. At the culmination of the event, Naibu Kelle announced Bitcoin City, powered by Bitcoin and finance with a $1 billion volcano bond. So here are the details. Bitcoin City will have residential and commercial areas. It'll have restaurants. It'll have an airport. It'll have port and rail service. It'll be laid out in a circle like a coin and in the center, a plaza with a huge Bitcoin logo. Much more relevantly,

it will also have no income tax, no property tax, no capital gains or payroll tax. Indeed, the only tax in the city will be a 10% sales tax. So the question is, how will they finance it? Well, the country also announced that they're issuing a $1 billion Bitcoin bond, which people are calling a volcano bond. Of that, $500 million will be used to help construct infrastructure and the other half will be used to buy even more Bitcoin. The bond is tokenized by Blockstream via the liquid network. The bonds will be 10-year U.S. dollar denominated and have a coupon rate of 6.5%. There will be a lock-up period of five years, and once that lock-up has ended, El Salvador will start to sell crypto to pay an additional dividend. Interestingly, part of the

pitch is that removing another half billion in Bitcoin from circulation will help contribute to price appreciation. There are a lot of different takes on this. First of all, there is the quite reasonable awe at just how wild and rapidly evolving things are. Dylan LeClair tweets, mining Bitcoin with geothermal energy from volcanoes was an idea first suggested to Naibu Kelle in Twitter spaces. Issuing $1 billion of bonds against the future output have said Bitcoin miners was first suggested in a tweet. Both are now being implemented. This is the best timeline. Hoddling Carla tweets last night we witnessed history. Volcano bonds will soon fund Bitcoin Bitcoin will be legal tender and the only tax will be a 10% sales tax. The first Citadel is

coming to life. Samson Mao from Blockstrain tweets, what did you do today? Oh, just connected the El Salvador Volcano Bitcoin Mine to the Blockstream satellite network. And listen, I do think it's worth taking a pause to appreciate this. It's a massive, brain-changing thing to see how far the discussion around Bitcoin and what it can do and how it intersects with geopolitics has come in such a short period of time. However, there was another take, one of the most frequent that I saw that had to do with geopolitical competition among nations. Nick Can't Mind tweets El Salvador's Bitcoin City will offer zero percent income tax, 0% capital gains tax, 0% property tax, and 0% payroll tax.

Remember Biden and yelling wanting to tax your unrealized gains? Nation state game theory in full swing. Peter McCormick tweets, Costa Rica wants to introduce a 13% value added tax and 15% capital gains tax on Bitcoin. El Salvador is issuing $1 billion Bitcoin bond and building a city free of income and capital gains tax. Winners and losers define themselves. Dylan LeClair again says El Salvador using $500 million of a debt raise to buy Bitcoin is vastly underappreciated. El Salvador's GDP is 26 billion, 103rd globally, and they aren't issuers

of their own currency. What happens when a larger nation that can print their own money does the same thing? Preston Pish says if the rest of the world isn't paying attention they're about to. El Salvador is the micro-strategy of nation states. Now, to me, an even more interesting geostrategic angle has to do with the relationship between the IMF and El Salvador. Almost exactly a month ago, there were dozens of articles like this one from Fortune. El Salvador needs an IMF loan. Its central bank thinks Bitcoin can sweeten the deal. Basically, this article is all about how the IMF and El Salvador were in talks for a $1.3 billion

extended fund facility. The IMF was reviewing El Salvador's finances and economics, and the Buckelly administration was saying that Bitcoin was actually going to be a boon to that process. However, as Fortune points out, quote, though the nation doesn't have major dollar bond payments until 2023, it's highly indebted and needs a deal with the multilateral lender to unlock access to international markets next year. Now, some people are seeing the volcano bonds as an end run around the IMF. Alex Gladstein says,

If you're a developing country, would you rather issue $1 billion of bonds based on your renewable energy reserves, or take out a $1 billion loan from the World Bank? Andy Yee writes, The IMF and World Bank are being disintermediated right before our eyes, and Kent Taliburton writes Bitcoin now being used to tame the IMF, gradually, then suddenly. But of course, there are plenty who, even if they don't care one way or another, if El Salvador can do this, think it's a stupid offering for people to buy. Josh Gersh, a product dev at Visa and X Rippler, says the Bitcoin bonds are 6.5% USD bonds, but El Salvador's existing USD bonds all trade at 70.

The bond is way overpriced, and they're using it to make leverage Bitcoin bet with OPM. The buyers are getting suckered. I don't think it's an exaggeration to say Bucle is pulling a grip on Bitcoiners. He's using Bitcoin as an affinity vehicle to get cheap funding that he can't get through regular capital markets, because existing emerging market lenders see right through him. If El Salvador has to raise dollar funds through normal bonds, they'd have to pay mid-double-digit interest rates if they could issue at all, which is a dicey proposition.

But waving the buy-with-bitcoin, Magic Wand, gets them five-year funding on a six-handle? No, you're getting suckered. Matt Levine makes sort of a similar point in his column today, saying the point I want to make here is that this is an example of market segmentation by standing in front of a PowerPoint presentation at a Bitcoin party wearing a backwards baseball cap. This is market segmentation by slapping a cool name Volcano Bond on a bond that is strictly

worse than a readily available alternative. This is market segmentation by combining a normal thing with one, crypto and two, a huge markup, and then marketing it to crypto people who want to pay the huge markup not to buy crypto, but to buy into a crypto adventure. I understand I am being dense by writing all of this. The point of the volcano bonds is that they live on a crypto trading platform, and people who like crypto will buy them and trade them with each other and feel a sense of kinship and community and fun.

They are hodlers and whales. they get to hang out with the president of a country on a Saturday night, all this stuff. The specific terms of the financial investment don't matter. Fine, yes, fine, people like to join clubs. People like to buy things for reasons other than their financial returns. It is a weird thing to do this with a financial instrument. I feel like this is the main story of finance in 2021. I bought that stock, bond, cryptocurrency, etc.

to be part of a cool club, not because it made financial sense. I don't know. So I think this one is really fascinating. I think that you can actually hold two different opinions simultaneously. that it doesn't make sense as a financial investment, that the IMF might even be punitive in return, but still see this as a strong assertion of El Salvador's sovereignty. This is what a permissionless network looks like in action. El Salvador didn't have to ask the IMF if it had permission to issue this bond. It's just doing it. And to Matt Levine's critique, I think that

there may be a market price to financing sovereignty that a lot of Bitcoiners are willing to pay. Ultimately, money is about what your objectives for it are, and there are a hell of a lot of bitcoinsers who are going to be really excited about this. Does that make it a good financial investment? I don't know. But thank goodness, I'm not a financial podcast. I'm a macro podcast that's all about shifts in power. And boy, howdy, does this look like an attempt at a shift in power? Until tomorrow, guys, be safe and take care of each other. Peace.